4 Things Borrowers Should Know About Hard Money Collateral

Successfully obtaining a hard money loan requires having adequate collateral to offer. Because hard money lending is asset-based, collateral is everything. Collateral is the basis on which approvals are given. A lack thereof virtually guarantees loan denial.

Although hard money lenders have the freedom to lend for any need, nearly all hard money loans fund real estate transactions. As such, the real estate itself acts as collateral for a loan. It needs to be valuable enough to cover the amount being borrowed.

Actium Partners, a Utah hard money lender based in Salt Lake City, explains that lenders assess properties to determine current market value and sale potential. Appraisal value plays a significant role in determining how much a lender can borrow. If a borrower wants more than the property can support, his loan request will most likely be denied.

All of this said, here are four things that borrowers should know about hard money collateral going in:

1. What Lenders Look At

When a lender looks at a piece of property, its current market value is just one aspect. Lenders also look at property condition, location, sale potential, and profit potential. They need to know more than just current market value in case it becomes necessary to recover on a defaulted loan.

Lenders are understandably concerned about how easily they can unload a property. After all, they aren’t interested in being landlords. Should it become necessary, they want to be able to quickly seize and sell a property to recover their money. So if a property’s profit or sale potential are questionable, a loan could be denied.

2. Property Valued Affects Loan Terms

The value of the applicant’s collateral almost always has an effect on loan terms. Remember that collateral is security on a hard money loan, just as a consumer’s estimated ability to repay is collateral on a conventional loan. When a conventional borrower has poor credit, they are subject to less favorable terms. Likewise, a weaker property acting as collateral on a hard money loan generally leads to less favorable terms as well.

3. LTV Ratios Are Much Lower

Loan-to-value ratios (LTVs) on hard money loans tend to be much lower compared to conventional loans. Although LTVs typically run at 65-75% in hard money, 50% is not out of the question. What does this have to do with collateral? Simply put, collateral value directly impacts both LTV and the size of the down payment a borrower will need.

If an appraisal of a targeted property values it at $1 million while the lender’s LTV is 65%, the most the lender would be willing to put out is $650,000. The borrower would have to come up with the remaining sum in order to purchase the property.

4. Lenders Don’t Like to See Liens

Finally, hard money lenders do not like to see liens on collateral property. They prefer to be in the first position, but an existing lien would put them in a less desirable position. Second or third position seems very unattractive to most hard money lenders. Those that are still willing to lend are most likely to offer less desirable rates and terms based on lien position.

Collateral truly is everything in the hard money game. It is the basis on which approval decisions are made. Its value, location, and potential all impact loan rates and terms. As a borrower, the strength of your collateral directly correlates to the amount of money you can borrow and the favorability of the rates and terms. High value collateral is good. Low value collateral, not so much.